Golden Rules of Accounting

The accounting process involves recording, classifying, and summarizing the financial transactions of a business or organization. Basically, accounting refers to a process where financial transactions are recorded systematically to keep a chronological record of what happened at each stage.

The financial information of every economic entity must be presented to all stakeholders. To provide a true picture of the entity, the financials must be accurate. Each of its transactions must be included in this presentation. The purpose of accounting is to understand financial status of economic entities by comparing them. In order to ensure uniformity and to account for transactions correctly, there are three Golden Rules of Accounting. Accounting and bookkeeping are based on these rules. Journal entries are the basis of this.

Understanding the types of accounts is the first step toward understanding the Golden Rules of Accounting. There are many different types of general ledgers. Therefore, every account will fall into one of the broad categories below. There are three types of accounts:

Real Account: In general ledger accounts, Real Accounts refer to Assets and Liabilities other than people accounts. They are accounts that don’t close at year-end and are carried forward. Bank accounts are a good example of these accounts.

Personal Account: A Personal account is a General Ledger account that is associated with every individual, firm, or association. A creditor account is an example of a Personal Account.

Nominal Account: A Nominal account is a General Ledger account that reflects all income, expenses, losses and gains. Interest is an example of a Nominal account.

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3 Golden rules of accounting


The world of accounting is run by credits and debits. Debits and credits make a book’s world go ‘round.

Before we dive into the golden principles of accounting, you need to brush up on all things debit and credit.

Debits and credits are equal but opposite entries in your accounting books. Credits and debits affect the five core types of accounts:

  • Assets: Resources owned by a business that have economic value you can convert into cash (e.g., land, equipment, cash, vehicles)
  • Expenses: Costs that occur during business operations (e.g., wages, supplies)
  • Liabilities: Amounts owed to another person or business (e.g., accounts payable)
  • Equity: Your assets minus your liabilities
  • Income and revenue: Cash earned from sales

A debit is an entry made on the left side of an account. Debits increase an asset or expense account and decrease equity, liability, or revenue accounts.

A credit is an entry made on the right side of an account. Credits increase equity, liability, and revenue accounts and decrease asset and expense accounts.

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You must record credits and debits for each transaction.

The golden rules of accounting also revolve around debits and credits. Take a look at the three main rules of accounting:

  • Debit the receiver and credit the giver
  • Debit what comes in and credit what goes out
  • Debit expenses and losses, credit income and gains

1. Debit the receiver and credit the giver

The rule of debiting the receiver and crediting the giver comes into play with personal accounts. A personal account is a general ledger account pertaining to individuals or organizations.

If you receive something, debit the account. If you give something, credit the account.

Check out a couple of examples of this first golden rule below.

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Example 1

Say you purchase $1,000 worth of goods from Company ABC. In your books, you need to debit your Purchase account and credit Company ABC. Because the giver, Company ABC, is providing goods, you need to credit Company ABC. Then, you need to debit the receiver, your Purchase account.

DateAccountDebitCredit
XX/XX/XXXXPurchase1,000
Accounts Payable1,000
Golden Rules of Accounting

Example 2

Say you paid $500 cash to Company ABC for office supplies. You need to debit the receiver and credit your (the giver’s) Cash account.

DateAccountDebitCredit
XX/XX/XXXXSupplies500
Cash500
Golden Rules of Accounting

2. Debit what comes in and credit what goes out

For real accounts, use the second golden rule. Real accounts are also referred to as permanent accounts. Real accounts don’t close at year-end. Instead, their balances are carried over to the next accounting period.

A real account can be an asset account, a liability account, or an equity account. Real accounts also include contra assets, liability, and equity accounts. 

With a real account, when something comes into your business (e.g., an asset), debit the account. Credit the account when something goes out of your business.

Example

Let’s say you purchased furniture for $2,500 in cash. Debit your Furniture account (what comes in) and credit your Cash account (what goes out).

DateAccountDebitCredit
XX/XX/XXXXFurniture2,500
Cash2,500

3. Debit expenses and losses, credit income and gains

The final golden rule of accounting deals with nominal accounts. A nominal account is an account that you close at the end of each accounting period. Nominal accounts are also called temporary accounts. Temporary or nominal accounts include revenue, expense, and gain and loss accounts.

With nominal accounts, debit the account if your business has an expense or loss. Credit the account if your business needs to record income or gain.

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Example: Expense or loss

Say you purchase $3,000 of goods from Company XYZ. To record the transaction, you must debit the expense ($3,000 purchase) and credit the income.

DateAccountDebitCredit
XX/XX/XXXXPurchase3,000
Cash3,000

Example: Income or gain

Say you sell $1,700 worth of goods to Company XYZ. You must credit the income in your Sales account and debit the expense.

DateAccountDebitCredit
XX/XX/XXXXCash1,700
Sales1,700

https://en.wikipedia.org/wiki/Double-entry_bookkeeping

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